Married, filing jointly, ages 55.They need $100,000 a year after-tax to pay for expenses. Typical rule of thumb is that the sustained withdrawal rate from a portfolio is 4%, but they also have the possibility of Social Security benefits that would go towards that $100K, so give the couple $2 million in a portfolio split half in taxable and half in tax-advantaged. Of the tax-advantaged, 94% is in tax-deferred 401(k), 403(b), traditional IRA accounts and 6% in Roth IRAs.

They have been diligently tax-loss harvesting and the stock market has not done so well in the last few years, so their net gains in the taxable assets are essentially zero. That is, they have enough carryover losses to deduct $3,000 from ordinary income each year for quite a while. If they sell any taxable assets, the net capital gain will be essentially zero for a number of years. Their taxable portfolio generates 2% in qualified dividends each year. They get a foreign tax credit as well. They live in a state with no state income taxes.

They have a kid in college and one in high school who will go to college, thus they will get education credits, but they pay for college partially out of 529 plans (not included in portfolio described above).

They have no debts and own their home mortgage-free. They take the standard deduction in odd years and bunch property taxes and charitable contributions into even years.

They will delay taking SS until age 70 while converting their tax-deferred assets to Roth IRAs between ages 55 and 70.

OK, that's the setup. Any comments before we compute the taxes and the amount of Roth conversions each year?

Last edited by livesoft on Thu Dec 22, 2011 5:43 am, edited 1 time in total.

paying zero taxes isnt the most important part. too many people use the tax scare to sucker people into poor investments such as permanent life insurance. thus one should only care about paying zero taxes if it really provides you with the most money. thus the title should be providing the most income in retirement by reducing taxes to near zero if that is what you plan to show.

Alas, I tried that one year and the county would not take my advance payment of real estate taxes in December.

Many states have two due dates: one in the fall and one in the spring. We get sent the two payment stubs at the same time in the fall for a tax year that ends on June 30. There is nothing wrong with paying both with one check in one envelope before the first deadline. If you pay your taxes as follows, you get three payments in one calendar year every other year.

tax year 1: one payment in November of calendar year 1, one payment in February of calendar year 2.tax year 2: two payments in November of calendar year 2.tax year 3: one payment in November of calendar year 3, one payment in February of calendar year 4.rinse and repeat.

Calendar year 2 has three payments; calendar year 3 has one payment, and so on.

Alas, I tried that one year and the county would not take my advance payment of real estate taxes in December.

Many states have two due dates: one in the fall and one in the spring. We get sent the two payment stubs at the same time in the fall for a tax year that ends on June 30. There is nothing wrong with paying both with one check in one envelope before the first deadline. If you pay your taxes as follows, you get three payments in one calendar year every other year.

tax year 1: one payment in November of calendar year 1, one payment in February of calendar year 2.tax year 2: two payments in November of calendar year 2.tax year 3: one payment in November of calendar year 3, one payment in February of calendar year 4.rinse and repeat.

Calendar year 2 has three payments; calendar year 3 has one payment, and so on.

We get one bill at the end of June. You can pay it all in July and take a 3% discount, pay it in full in August or start paying installments where the installments have a 3% adder and have to be paid by December. On the other hand, our property taxes are very low by national standards so I can't really complain.

When you discover that you are riding a dead horse, the best strategy is to dismount.

From tax tables for married filing jointly, gross income tax due = $3496- $1000 Child tax credit, assuming the HS student is under 17 or whatever the age cutoff is for this credit- $2500 American Opportunity Tax Credit, assuming at least $4000 in eligible expenses Net income tax = $0

Income: $0Dividends: 2% from $1 million -> +$20,000, tax rate - 0% (if in 10-15% bracket)Sell $80,000 assets in taxable, which are offset by previous lossesMove Trad. Ira to Roth Ira: ~$30,800 to be offset by the items below +college deduction.Loss carryover: -$3,000 Standard deduction: -$11,900.Personal exemption: -$14,800Child tax credit : -$1,000(supplement the income with RothIRA withdrawals after 60 in order to get to $100K).

Taxes: $0

After 70: Income: Social SecurityTaxable assets: $0RothIRA/TradIRA split should be ~50/50 (depending on the college deduction).Pay taxes on SS. Don't know details about the tax code in 15 years.

A tax guru associate of mine once told me that if you find a legal way to reduce your taxes in a manner that is not generally known, shut up about it. History has shown that it eventually comes to the attention of the IRS and Congress and the opportunity is lost. A good example is the limited partnerships that were so effective in the '80's but which were eventually plugged.

A non-tax example of an attractive situation that was talked about way too much on this board, was the opportunity to purchase Savings Bonds with credit cards. This came to the attention of the Treasury as well as the banks and we are now limited to a cash purchase of $5,000. I felt at the time that too much discussion was going to kill the golden goose and, sure enough, it did.John

The tax code is so complex that with a little jiggling here and a little wiggling there, you can pretty much create any hypothetical outcome to any hypothetical factual situation that you choose. Whether the hypothetical has any bearing on real life for the vast majority of people, however, is a totally separate issue....

As I pointed out in another thread less than one minute ago, because they are fun. I read this board and post for fun. If it weren't fun, why would I waste my time? As it is, I spend five hours a day watching Chinese soap operas (they are called dramas, be we know they are really soap operas) and five hours a day on bogleheads. I do both for fun. If bogleheads were not fun, I would watch Chinese soap operas ten hours a day and not waste my time here.

Last edited by sscritic on Thu Dec 22, 2011 11:39 am, edited 1 time in total.

retiredjg wrote:having lots of money and but paying only a little tax.

Since the press gets wealth and income mixed up all the time, I'll add that it's also possible to have lots of income and pay only a little tax.

I think the "expenses" part of livesoft's title is supposed to emphasize that you don't necessarily have to have income to cover living expenses; I think that's been misunderstood in the thread. We get many posters in the accumulation phase of life who don't appreciate the flexibility you have in retirement or early retirement or partial retirement to manipulate the amount and type of income you have.

These are good exercises for people to go through. I have said before, I am constantly amazed at how much mental energy some people will invest to save $10-20 on their cable bill or phone bill when the biggest expense in their entire life is probably taxes. I recently explained tax loss harvesting to a very savvy investor/friend and he looked at me like I had invented the wheel.

Bob's not my name wrote:We get many posters in the accumulation phase of life who don't appreciate the flexibility you have in retirement or early retirement or partial retirement to manipulate the amount and type of income you have.

This will be the second year I will be paying zero or <$100 in Federal taxes as a result of taking SS and limiting my IRA withdrawals. It will be fun while it lasts! (Edit: Fixed who made the statement]

Last edited by BigFoot48 on Thu Dec 22, 2011 12:58 pm, edited 1 time in total.

retiredjg wrote:We get many posters in the accumulation phase of life who don't appreciate the flexibility you have in retirement or early retirement or partial retirement to manipulate the amount and type of income you have.

This will be the second year I will be paying zero or <$100 in Federal taxes as a result of taking SS and limiting my IRA withdrawals. It will be fun while it lasts!

And don't forget taking social security at 62 and then paying it all back and reapplying at 70 if you were still alive. That was taken away just over a year ago.

You're so right, sscritic. I remember thinking that at the time it was being so actively discussed. Too many people taking advantage of a good thing and I'm sure Social Security decided enough is enough.John

livesoft wrote:OK, provocative thread title. Let's see if it holds water....OK, that's the setup. Any comments before we compute the taxes and the amount of Roth conversions each year?

The thread is provocative only to the extent that it emphasizes ZERO taxes. If one reads it with an eye for MINIMIZING taxes, a few prudent financial approaches can be identified in the OP message, including (in no particular order) the following:1. Tax-loss harvesting.2. Living in a state without state income tax.3. Having a paid off house.4. Getting education credits, while paying for the children's college out of the 529 plans.5. Combining various deductions to do itemized deductions every other year.6. Postponing taking Social Security until the age of 70 and using the early retirement years for converting tax-deferred accounts into Roth accounts.

However, ZERO or MINIMUM taxes are secondary to having money to start with. And having money is generally secondary to having a satisfying life. And so some of these tax-saving approaches are not relevant to most people, and even when they are relevant, the trade-offs may not be worth it. For example, one may want to live in a high-taxing city as a matter of quality of life (New York City comes to mind). Another one may not want to own house to be able to move around (both in the U.S. and abroad). The third one does not have college-age children.

Pay off their mortgage from their taxable account. This would greatly reduce their cash requirements each year and then they could still take the standard deduction. Withdrawing money from a 401K to pay the mortgage negates any mortage interest deduction.

A part time "fun" job that brings in $12,000 a year between them would allow them to contribute $12,000 a year from their taxable accounts to the Roth instead of rolling it over from an IRA.

Some "just thinking out loud" ideas for further discussion;

If they are real careful about their other retirement account withdrawals and where there other money comes from, then they might even be able to qualify for a retirement contribution credit and maybe an earned income credit.

When they do the Roth conversion in 2012 they could do it in January of 2012 so they could recharacterize it back to a IRA until their filing deadline the next year which if I remember correctly is as late as October 2013 with extensions. With different his and her accounts can they do two Roth conversions in one year and invest one on "black" and the other on "red" and then just recharacterize the one that loses? This would effectively cut the taxes on the Roth conversion in half.

If they didn't already live in a state with no income taxes, they could temporarily "move" to a state with no income tax and do the Roth rollover while they travel in their RV or take other expended vacations.

As I pointed out in another thread less than one minute ago, because they are fun. I read this board and post for fun. If it weren't fun, why would I waste my time? As it is, I spend five hours a day watching Chinese soap operas (they are called dramas, be we know they are really soap operas) and five hours a day on bogleheads. I do both for fun. If bogleheads were not fun, I would watch Chinese soap operas ten hours a day and not waste my time here.

YMMV may vary, but the exercise doesn't strike me as being particularly fun.

I may, and often do, take some particular action to legally minimize my tax bill, but having children* isn't one of them. I suspect that others act likewise.

Thus, the hypothetical exercise seems to me more about "based on today's tax code, if I have X, Y, and Z, regardless of how improbable the combination of X, Y, and Z as I have set them out may be, what do I end up with" than anything else. I can't say that I see a lot of value in engaging in that type of exercise except for and as to the hypothetical family in question and, I suppose, those situated exactly the same as them.

* Noted solely because it sure seems to me that many of these "hypothetical tax" threads involve the existence of children and that they are always at just the "right" age.

VictoriaF wrote:However, ZERO or MINIMUM taxes are secondary to having money to start with. And having money is generally secondary to having a satisfying life. And so some of these tax-saving approaches are not relevant to most people, and even when they are relevant, the trade-offs may not be worth it.

This is a good point. But, I suspect the thread may actually be aimed at a different group - people who are paying 40% or more in taxes now to move money into Roth status, because they think they will be paying lots of taxes in retirement.

Random Poster wrote:...Thus, the hypothetical exercise seems to me more about "based on today's tax code, if I have X, Y, and Z, regardless of how improbable X, Y, and Z may be, what do I end up with" than anything else. I can't say that I see a lot of value in engaging in that type of exercise except for and as to the hypothetical family in question and, I suppose, those situated exactly the same as them.

* Noted solely because it sure seems to me that many of these "hypothetical tax" threads involve the existence of children and that they are always at just the "right" age.

You are welcome to add any different hypothetical scenario you would like and show how to minimize taxes under that scenario.

I will say that the OP is not so hypothetical. Polls on the forum show that (a) many folks here are multimillionaires, (b) many folks here have children, (c) many folks here will own their home free and clear, and (d) many folks here retire early.

So far, hsv_climber is the most on-track. There are a number of Roth conversion threads and "Roth 401(k) vs Trad 401(k)" threads that this thread will be relevant for as retiredjg has hinted at.

Also I am somewhat surprised that no one wrote as the answer: "Taxpayer dies right away and owes no taxes."

livesoft wrote:I will say that the OP is not so hypothetical. Polls on the forum show that (a) many folks here are multimillionaires, (b) many folks here have children, (c) many folks here will own their home free and clear, and (d) many folks here retire early.

livesoft wrote:I will say that the OP is not so hypothetical. Polls on the forum show that (a) many folks here are multimillionaires, (b) many folks here have children, (c) many folks here will own their home free and clear, and (d) many folks here retire early.

You just modified the hypothetical.

original hypothetical wrote:They have no debts and own their home mortgage-free.

Income: $0Dividends: 2% from $1 million -> +$20,000, tax rate - 0% (if in 10-15% bracket)Sell $80,000 assets in taxable, which are offset by previous lossesMove Trad. Ira to Roth Ira: ~$30,800 to be offset by the items below +college deduction.Loss carryover: -$3,000 Standard deduction: -$11,900.Personal exemption: -$14,800Child tax credit : -$1,000(supplement the income with RothIRA withdrawals after 60 in order to get to $100K).

Taxes: $0

After 70: Income: Social SecurityTaxable assets: $0RothIRA/TradIRA split should be ~50/50 (depending on the college deduction).Pay taxes on SS. Don't know details about the tax code in 15 years.

Actually we don't know the details about what the tax code will be even in 2013.

The taxpayer has one kid in college and one in HS. They won't get the $1000 child tax credit for 15 years as that ends at age 17 and, under current law ends after 2012. They would get college tax credits, but I think the American Opportunity Credit ends after 2012 and will revert to the Hope Credit. So depending on the actual ages of the kids and assuming they go to college they will get college tax credits of some amount during certain years.

Actually, as I am thinking about it, maybe the kids could continue on in school, piling up degrees and if tuition is at least $10,000 each and the kids earn less than $3700 per year, the parent's can continue to take a $3700 deduction for each and a $2000 lifetime learning credit for each.

livesoft wrote:I will say that the OP is not so hypothetical. Polls on the forum show that (a) many folks here are multimillionaires, (b) many folks here have children, (c) many folks here will own their home free and clear, and (d) many folks here retire early.

You just modified the hypothetical.

original hypothetical wrote:They have no debts and own their home mortgage-free.

Are you arguing about use of the future tense?

In the post that livesoft quoted, I stated that I can't see a lot of value in the hypothetical exercise except "for and as to the hypothetical family in question and, I suppose, those situated exactly the same as them." Given that the tax code changes every year, someone who "will own their home free and clear" in the (undefined) future is not the same as, nor likely treated the same tax-wise as, someone who "own[s] their home mortgage-free" today.

RandomPoster, Livesoft's scenario does take advantage of certain rules that may expire such as low tax rates for QDI/LTCG and maybe some tax credit. Other parts of the scenario takes advantage of rules that are unlikely to change:

1. Capital loss carryovers offset future capital gains. Investors with taxable accounts who have capital loss carryovers can harvest losses as they appear and use them to offset gains realized in the future. The current low rates for QDI/LTCG are scheduled to expire at the end of 2012 which means higher LTCG tax rates in 2013. Many investors harvested losses in 2008/2009 when LTCG tax rates were very low and to the extent that the loss carryovers are still available in 2013 and beyond, they are immune to future increases in CG tax rates.

2. Specific share identification to control of how much gain to realize when withdrawing from taxable account. A retiree may need to raise 100K to meet expenses. He/she find shares with 90K basis in the taxable account which means only 10K realized gain.

3. Deductions and exemptions provide a 0% tax bracket to every taxpayer even if they don't fit into livesoft's scenario. The 0% bracket is even larger for those who itemize deductions so YMMV. The 0% bracket helps reduce every taxpayer's effective/average tax rate. The std deduction and exemptions adjusts every year for inflation I believe.

Bottom line, even people who don't fit exactly into livesoft's hypothetical can be can benefit or learn something from it.

livesoft wrote:OK, provocative thread title. Let's see if it holds water....OK, that's the setup. Any comments before we compute the taxes and the amount of Roth conversions each year?

The thread is provocative only to the extent that it emphasizes ZERO taxes. If one reads it with an eye for MINIMIZING taxes, a few prudent financial approaches can be identified in the OP message, including (in no particular order) the following:1. Tax-loss harvesting.2. Living in a state without state income tax.3. Having a paid off house.4. Getting education credits, while paying for the children's college out of the 529 plans.

Victoria

Expenses paid with tax-advantaged funds (like 529 plans) do not qualify for Education credits so they would have to pay up to 4K (for AOC) or 10K (for the LLC) with other funds

pshonore wrote:Expenses paid with tax-advantaged funds (like 529 plans) do not qualify for Education credits so they would have to pay up to 4K (for AOC) or 10K (for the LLC) with other funds

Well, you can pay them with the 529 money and take the tax credits, it's just that then you would have to pay taxes, but no penalties, on the 529 gains (and there may not be any gains). But you can also use the 529 to pay things like room and board which are not eligible for the tax credits, anyway.

Some tools to figure some of this out are found at the Optimal Retirement Planner calculator, the Intuit TaxCaster calculator and the more involved TurboTax. Let's start with the first one found at http://www.i-orp.com to get some ballpark estimates of what we need to do.

You can plug in the numbers from the OP yourself. You can estimate how much SS benefits they will get. I think I have underestimated it by saying he will get $11K a year and she will also get $11K a year (they both worked before retirement at decent jobs, after all, how else are they gonna accumulate $2M and a paid-off McMansion?) Here's a bit of the output:

The i-orp output suggests that they will pay $2K in taxes in the 1st and 2nd years of retirement, and zero income taxes until age 70. It also suggests that those $2K in taxes are at the 10% marginal income tax rate and that the couple is never above the 15% marginal tax bracket. Conversions to Roth IRA are between $28K and $34K a year. Of course, all this is an estimate and makes no use of some of the details in the OP, so let's go use TaxCaster and put in some of those details.

Give the couple $20K in qualified dividends, the two kids, the college expenses and a $3K capital loss. This gives them some tax credits which are very helpful. I will ignore any foreign tax credit for now, but they may be eligible for $600 foreign tax credit though I am not sure about this since they won't be paying any taxes for a while. Maybe the FTC can be carried over to the future? TaxCaster says that they can convert about $58,400 to a Roth IRA and pay no income taxes. That's quite a bit different than the $34K calculated by I-ORP and there is no $2K tax.

That was all with the standard deduction (say an odd year). For even years, give them $12K in property taxes and $16K in charitable donations ($6K and $8K per year). With itemizing these deductions, TaxCaster says that they can convert about $74,500 to a Roth IRA and pay no income taxes.

That sets the stage for a more detailed analysis with TurboTax itself. Can the couple get all their tax-deferred assets converted to Roth IRAs by age 70? Maybe. Maybe not. The average conversion in the first few years is more than $66K per year. It is true that the youngest kid will graduate from college in 6 to 7 years. Also do not forget that their taxable assets have no net gains that will eventually be used up. Hopefully, the value of those assets will increase, but at the same time withdrawals may diminish the amount of qualified dividends received.

Anyways, folks can reproduce my results (or not) before I get the latest version of TurboTax to use in my scenario(s). Comments welcome.

Just a reminder: That money that went into the tax-deferred 401(k) and traditional IRAs was tax-free going in and it appears to be tax-free coming out. That's way better than a Roth IRA and a Roth 401(k). This thread should put to rest which is better: Roth 401(k) or Traditional 401(k).